Buy now, pay later loans are contributing to a record-breaking holiday shopping season. Economists fear they could also obscure and exacerbate gaps in Americans' financial well-being.
Loans, which allow consumers to pay for purchases in installments, often interest-free, have become very popular due to the high prices and interest rates. Retailers have used them to attract customers and get people to spend more.
But consumer groups and some lawmakers say such loans could encourage younger and lower-income Americans to take on too much debt. And because such loans are not routinely reported to credit bureaus or recorded in public data, they could also represent a hidden source of risk to the financial system.
“The more I look into it, the more worried I am,” said Tim Quinlan, a Wells Fargo economist who recently released a report calling deferred loans “phantom debt.”
Traditional measures of consumer credit suggest that U.S. household finances are relatively healthy overall. But, says Quinlan, “if they're missing out on the fastest growing market share, then those assurances aren't worth it at all.”
Estimates of the size of this market vary widely. Mr Quinlan estimates that spending on the pay later option was about $46 billion this year. That's small compared to the more than $3 trillion that Americans loaded onto their credit cards last year.
But such loans — offered by companies like Klarna, Affirm, Afterpay and PayPal — have risen quickly at a time when some Americans' finances are beginning to show signs of strain.
Credit card borrowing is at a record high in dollar terms – although not relative to income – and delinquencies are increasing, although they are low by historical standards. This stress is particularly evident in younger adults.
According to the Federal Reserve Bank of New York, people in their 20s and 30s are by far the largest users of deferred loans. This could be both a sign of financial problems – young people may turn to deferred loans after maxing out their credit cards – and a cause, encouraging them to overspend.
Liz Cisneros, a 23-year-old student from Chicago who works part-time at Home Depot, said she was surprised by the simplicity of pay-later programs. During the pandemic, she saw influencers on TikTok promoting the loans, and a friend said they helped her buy designer shoes.
Ms. Cisneros began buying clothes, shoes and beauty products from Sephora. She often had several loans at the same time. She realized she had overspent when she didn't have enough money at the checkout at a grocery store. A pay later company had taken money out of her bank account that morning and she had lost track of her payment schedule.
“It's easy when you keep clicking and clicking and clicking and then you stop clicking,” she said, referring to the moment she realizes she's overspent.
Ms. Cisneros said the problem was particularly severe around Christmas and she didn't shop for the holidays this year to help pay off her debts.
Pay-later loans have been available in the United States for years, but they have seen a resurgence during the pandemic as online shopping surged.
The products are somewhat similar to the layaway programs offered by retailers decades earlier. Online shoppers can choose between pay later options at checkout or in companies’ pay later apps. The loans are also available in some physical stores; Affirm said Tuesday that it has begun offering pay-later credit at self-checkout checkouts at Walmart stores.
The most common loans require the buyer to pay a quarter of the purchase price upfront, with the remainder usually paid in three installments over a six-week period. Such loans are usually interest-free, although users sometimes incur fees. Pay later companies make most of their money by charging retailers.
Some lenders also offer interest-bearing loans with repayment terms that can range from a few months to more than a year.
Pay-later companies say their products are better for borrowers than credit cards or short-term loans. They say that by offering shorter loans they can better assess borrowers' ability to repay.
“We are able to identify and extend credit to consumers who have the ability and willingness to make repayments beyond those of revolving credit accounts,” Affirm Chief Financial Officer Michael Linford said in an interview.
Last quarter, 2.4 percent of Affirm's loans were 30 days or more delinquent, down from 2.7 percent a year earlier. These figures do not include four-payment loans.
The service is most useful for certain purchases, such as buying an expensive sweater that will last for many years, said Klarna's managing director, Sebastian Siemiatkowski.
He said paying later probably makes less sense for more frequent purchases like groceries, although Klarna and other companies make their credits available at some grocery stores.
Mr. Siemiatkowski acknowledged that people could abuse his company's loans.
“Obviously it's still a loan and so there will be a subset of people who unfortunately don't use it in the way it was intended,” said Mr Siemiatkowski, who founded Klarna in 2005. He said the company tried to identify these users and deny them loans or impose stricter conditions on them.
Stockholm-based Klarna says global default rates are less than 1 percent. In the United States, more than a third of customers repay loans early.
Kelsey Greco made her first pay-later purchase about four years ago to purchase a mattress. It would have been difficult to pay $1,200 in cash and it seemed unwise to pay for the purchase with a credit card. So she received a 12-month interest-free loan from Affirm.
Since then, Ms. Greco, 30, has used Affirm regularly, including for a Dyson hair clipper and car brakes. Some of the loans charged interest, but she said that even then she preferred this form of borrowing because it was clear how much she would pay and when.
“With a credit card, you can swipe all day and say, 'Wait, what did I just get myself into?'” said Ms. Greco, a Denver resident. “With Affirm, however, you get clear numbers that let you see, 'Okay, that makes sense' or 'That doesn't make sense.'”
Ms. Greco, who was introduced to The New York Times by Affirm, said pay-later loans helped her avoid credit card debt, which she had previously struggled with.
However, not all consumers are cautious about the possibility of paying later. A report this year from the Consumer Finance Protection Bureau found that nearly 43 percent of pay later users had overdrawn their bank accounts in the past 12 months, compared to 17 percent of non-users.
“This is just a more vulnerable portion of the population,” said Ed deHaan, a researcher at Stanford University.
In a paper published last year, Mr. deHaan and three other researchers found that within a month of first using deferred loans, people became more likely to experience overdrafts and incur late fees on credit card payments.
Financial advisors who work with low-income Americans say more and more clients are turning to deferred loans.
Barbara L. Martinez, a financial adviser in Chicago who works at Heartland Alliance, a nonprofit group, said many of her clients used cash advances to cover late-due loans. When the paychecks arrive, they are not enough to cover the bills, forcing them to resort to additional loans with delayed payments.
“It's not that the product is bad,” she added, but “it can get out of control very quickly and cause a lot of damage that could be prevented.”
Briana Gordley learned about pay-later products in college. She worked part-time and couldn't get approved for a credit card, but pay later providers were eager to extend her credit. When her hours were reduced, she fell behind. Eventually, family and friends helped her pay off the debt.
Ms. Gordley, who testified about her experiences in a Senate hearing last year, now works on consumer finance issues for Texas Appleseed, a progressive policy organization. She said pay-later loans could be an important source of credit for communities that don't have access to traditional loans. She still uses it occasionally for larger purchases.
But she said companies and regulators need to ensure borrowers can afford the debt they take on. “If we want to develop these products and build these systems for people, we just need to put some controls in place.”
The Truth in Lending Act of 1968 requires credit card companies and other lenders to disclose interest rates and fees and provides borrowers with various protections, including the ability to dispute fees. However, the law only applies to loans with more than four installments and effectively excludes many loans with later repayment.
Many of these loans are also not reported to the credit bureaus. This would allow consumers to take out multiple loans from Klarna, Afterpay and Affirm without the companies knowing about the other debts.
“It's a huge blind spot right now, and we all know that,” said Liz Pagel, senior vice president at TransUnion, who oversees the company's consumer lending business.
TransUnion and other major credit bureaus and pay later companies all support stronger reporting.
But there are practical hurdles. The credit scoring system rates borrowers higher if they have longer-term loans, including long-standing credit card accounts. Each pay later purchase is considered a separate loan. As a result, these loans could lower borrowers' credit scores even if they repay them on time.
Ms. Pagel said TransUnion created a new reporting system for the loans. Other credit reporting agencies like Experian and Equifax do the same.
Pay later companies say they report certain loans, particularly those with longer terms. But most don't report loans and don't commit to reporting loans with just four payments.
That worries economists, who say they are particularly worried about how such loans will play out if the economy weakens and workers lose their jobs.
Marco di Maggio, a professor at Harvard Business School who has studied pay-later products, said that in difficult times, more people would use such loans for smaller expenses and run into trouble. “It only takes one more shock to push people into default.”